What is Section 145?

Section 145 of the Income Tax Act, 1961 provides the method of accounting by the
individual taxpayer.

Section 145 is divided into three sub-sections

Section 145(1)

Section 145(1) provides that income chargeable under the head “Profits and gains of
business or profession” or “Income from other sources” shall be computed by either cash or
mercantile system of accounting regularly employed by the individual who is paying taxes.
There are some assessees which follow the mixed method of accounting, i.e. both Cash
method and Mercantile Method which does not compute the accurate income. Now the
assessees cannot use the mixed method. They have to either use Cash method or Mercantile
Method.

Provision 1: When the accounts are correct and complete but the method of accounting
deployed does not compute accurate income then, the computation of income will be done
by the assessing officer with the accounting method of his choice.
Provision 2: When an assessee has no regular method of accounting his income will be
calculated as per the method of accounting deployed for the last financial year.
Provision 3: If any interest on security that an individual receives has not been charged in
the earlier years, that does not mean that he won’t be charged for that in this year.
Section 145(2)

The Central Government may change the provisions related to the accounting standards in
the official gazette from time to time. These accounting standards must be followed by all
the assessees irrespective of the income slab he or she falls in.

Accounting Standards notified under section 145(2):

Accounting Standard I

 All significant accounting policies adopted in the preparation and presentation of financial
statements shall be disclosed.
 The financial statements should be made up of the significant accounting policies
 Any change in an accounting policy from the previous year or years earlier to that shall be
disclosed. Also, the impact it would have on the previous year and years earlier to that.
 Accounting policies adopted by an assessee should represent true and fair business proceedings:
1. Prudence – Provisions should be made for all known liabilities and loss, even though the
amount cannot be determined with certainty and represents only the best estimate in the
light of available information;
 2. Substance over form – The accounting treatment and presentation in financial statements of
transactions and events should be governed by their substance and not merely by the legal
form;
3. Materiality – Financial statements should disclose all material items, the knowledge of
which might influence the decisions of the user of the financial statements.
 If a fundamental accounting assumption is not followed, such fact shall be disclosed.
Accounting Standards II

 Prior period items shall be disclosed separately in the profit and loss account in the previous
year together with their nature and amount in a manner that their impact on profit or loss in the
previous year can be perceived.
 A change in an accounting policy shall be made only if the adoption of a different accounting
policy is required by statute or if it is considered that the change would result in a more
appropriate preparation or presentation of the financial statements by an assessee.
 Extraordinary items of the enterprise during the previous year shall be disclosed in the profit and
loss account as part of taxable income. The nature and amount of each such item shall be
separately disclosed in a manner so that their relative significance and effect on the operating
results of the previous year can be perceived.
 A change in an accounting estimate that has a material effect in the previous year shall be
disclosed and quantified. Any change in an accounting estimate which is reasonably expected to
have a material effect in the year subsequent to previous year shall also be disclosed.
 If a question arises as to whether a change is a change in accounting policy or a change in an
accounting estimate, such a question shall be referred to the Board for decision.
Section 145(3)

Provides that where the Assessing Officer is not satisfied

 about the correctness or completeness of the accounts of the assessee; or
 where the method of accounting provided in has not been regularly followed by the assessee; or
 income has not been computed by the standards notified
The assessing officer can reject the books of accounts concerning the following
discrepancies
 Improper Accounting Method
 No production of accounts for verification
 Failure to produce records
 Defective accounts
 Non-maintenance of stock register
After rejecting the books of accounts due dissatisfaction with the correctness of the
accounts produced by the assessee, the Assessing Officer must pass the best judgement
which is complying all the considerations of Section 145 of the Income Tax Act 1961.
Key Points relating to the Rejection of Books of Account

1. Opportunity to the assessee

The Assessing Officer has to give an opportunity to the assessee to contradict the materials upon
which the Assessing Officer wants to reject the books of account.
2. Estimation of profit
Once the books of account of the assessee are rejected, profit has to be estimated by proper
material available and nevertheless he is not entitled to make a pure guess and make an
assessment concerning any evidence or any material at all.
3. Estimate of turnover
The estimate of turnover and fixation of gross profit rate are two import parameters which affect
the assessment. If these are fixed or calculated in such a way that they adversely affect the
assessee’s case, then he is entitled to know the basis and to be given an opportunity to rebut the
same.
4. Peak credit
No reliance can be placed on rejected account books for working out Peak Credit. An assessee’s
business income is estimated after rejecting the books of account produced by the assessee; it is
not reasonable on the part of the Income Tax Officer to work out the Peak credit on the basis of
such books of accounts.
5. Reference to Valuation Officer
The Assessing Officer may, for the purposes of assessment or reassessment, make a reference to
a Valuation Officer to estimate the value, including fair market value, of any asset, property or
investment and submit a copy of the report to him only after rejecting the books of accounts.
6. Comparing gross profit of earlier years
If there is a heavy loss suddenly in the business of the assessee, it is his duty to explain the fall,
if so happens and to substantiate the reasons. Even if, thereafter, the Assessing Officer considers
the material placed before him by the assessee to be unreliable keeping in view the comparative
statement of accounts of the earlier years, he cannot proceed to changes in the accounts purely
due to guessing work. He can do only if he relates to some evidence or material on the records.
If the profit shown by the assessee in his return is not accepted, it is for the taxing authorities to
prove that the assessee made more profits. The rejection of books of accounts under Section
145(3) cannot be sustained merely on the fact that the gross profit of the assessee is low during
the relevant period as compared to the book results of other years. Similarly, the system of
accounting adopted by the assessee cannot be rejected merely on the ground that the gross
profits disclosed by his books were low as compared with those of others in the same line of
business.
7. Estimation of income/profit
Once the books are properly rejected, the income has to be estimated, and in making the
estimate of such income, the best record along with other things will become the relevant
material.
8. Power to be exercised judicially
The power to reject the books of accounts by the Assessing Officer is to be exercised judicially.
The Assessing Officer is to bring on record material on the basis of which he has arrived at the
conclusion with regard to correctness or completeness of the accounts of the assessee or the
method of accounting employed by it.
9. Power of First Appellate Authority
It is well-settled position of law that the Commissioner of Income Tax (Appeals) during the
appellate proceedings exercises all the powers vested with Assessing Officer to be exercised
while framing the assessment order. Therefore, the Commissioner (Appeals) can reject the
books of accounts of the assessee by invoking the provisions of Section 145(3) of the Act for the
first time while framing the appellate order provided with all other conditions exist warranting
reject of such books of accounts.
 10. No presumption
The Assessing Officer should not presume any material as valid for rejecting the books of
account. He must scrutinise it in every aspect and then reject it.
11. Explanation of the assessee
If the explanation given by the assessee is not satisfactory according to the Assessing Officer,
then he can reject the books of account.
What is Section 145A?

Method of accounting in certain cases—Notwithstanding anything to the contrary

contained in section 145, the valuation of purchase and sale of goods and inventory for the
purposes of determining the income chargeable under the head “Profits and gains of
business or profession” shall be
 in accordance with the method of accounting regularly employed by the assessee; and
 further adjusted to include the amount of any tax, duty, cess or fee (by whatever name called)
actually paid or incurred by the assessee to bring the goods to the place of its location and
condition as on the date of valuation.
Provisions of Section 145A

For the purpose of determining the income chargeable under the head “Profits and Gains of
business or profession”:
i. the valuation of inventory shall be made at lower of actual cost or a net realisable value
computed in accordance with the income computation and disclosure standards notified under
sub-section (2) of section 145.
ii. the valuation of purchase and sale of goods or services and of inventory shall be adjusted to
include the amount of any tax, duty, cess or fee actually paid or incurred by the assessee to bring
the goods or services to the place of its location and condition as on the date of valuation.
iii. the inventory being securities not listed on a recognised stock exchange, or listed but not quoted
on a recognised stock exchange with regularity from time to time, shall be valued at actual cost
initially recognised in accordance with the income computation and disclosure standards
iv. the inventory being securities other than those referred to in clause (iii), shall be valued at lower
of actual cost or net realisable value in accordance with the income computation and disclosure
standards notified under sub-section (2) of section 145.
What is Section 145B?

Section 145B is broadly categorized into three sub-sections 145B(1), 145B(2) and 145B(3)

Provision of Section 145B(1)

Notwithstanding anything to the contrary contained in section 145, the interest received by
an assessee on any compensation or on enhanced compensation, as the case may be, shall
be deemed to be the income of the previous year in which it is received.
Provision of Section 145B(2)

Any claim for escalation of price in a contract or export incentives shall be deemed to be the
income of the previous year in which reasonable certainty of its realisation is achieved.

The above-mentioned section deals with two types of income

 Any claim for escalation of price in a contract
 Export incentives
Provision of Section 145B(3)

The income from subsidy, grant or reimbursement shall be deemed to be the income of the
previous year in which it is received, if not charged to income-tax in any earlier previous
year.
The assessee must follow any one of the accounting methods Cash Accounting or
Mercantile Accounting for their income from profit and gains of business or profession
and income from other sources. The Central Government can make changes in the
provisions related to the accounting standards. All the assessees should follow those
changes despite their income slab. The Assessing Officer, before rejecting the books of
account, has to bring on record material on the basis of which he has arrived at the
conclusion with regard to correctness or completeness of the accounts of the assessee or
the method of accounting employed by it. The obligation on the part of the assessee is to
bring the accounts/documents before the Assessing Officer whenever it is required. The
Assessing Officer may resort to best assessment, the power of which shall be exercised
judicially and not violate the principles of natural justice. The valuation of purchase and sale
of goods and the deemed to be income of the previous year shall be followed as per the
provisions made by the Income Tax Department.
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